Retirement portfolio rebalancing when the market goes down, accumulation, de-accumulation, dollar cost averaging, and IRR, ROR, and CAGR (not “kegger”) as ways of calculating rates of return on investments. Plus step-up in basis, required minimum distributions (RMDs), capital accumulation life insurance plans, tax planning for new homebuyers, spousal Social Security benefits, and of course, backdoor Roth IRA conversions, though on YMYW they’re sometimes called “garage door” or “barn door” or… something.

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Show Notes

(00:53) How Should We Rebalance Our Portfolio in Downturns During Retirement?
(07:33) CAGR, ROR, IRR: How to Calculate Return on Investments
(14:05) Step Up in Basis and 401(k) Beneficiary: Spouse or Living Trust?
(20:00) CARES Act & SECURE Act: When Do I Have to Take My RMD?
(23:33) Should I Contribute to Roth IRA Instead of Traditional IRA?
(30:55) Should I Sign Up for My Employer’s Capital Accumulation (Life Insurance) Program?
(38:07) New Homebuyer Primary Residence Tax Planning
(41:54) Spousal Social Security Benefits

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Transcription

Today on the Smitty and Priya show – I mean, Your Money, Your Wealth® – plenty of financial concepts and acronyms to wrap your brains around: we’re talking about accumulation, de-accumulation, dollar cost averaging, IRR, ROR, CAGR – those are all ways of calculating rates of return on investments, by the way – as well as step-up in basis, required minimum distributions – there’s another acronym, RMD – capital accumulation life insurance plans, tax planning for new homebuyers, spousal Social Security benefits, and of course, those backdoor Roth conversions, but on YMYW it’s often the garage door, or something. But first let’s talk about portfolio rebalancing during retirement when the market goes down, and then let’s get to the fun stuff – keggers! I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

How Should We Rebalance Our Portfolio in Downturns During Retirement?

Joe: So we’ve got Tom from Lynnwood. Lynnwood, Washington. ” Hey Joe, Al and Andi. Thoroughly enjoy your podcast and learned a lot. Keep up the good work.” Apparently he hasn’t listened to this episode. God awful.

Al: Actually it’s not out yet. It will be. Or it may not be. Maybe this won’t make it. We’ll see.

Joe: It’s a hot, hot start.

Andi: This’ll all be ‘best of’.

Joe: “I’m interested in hearing your thoughts on rebalancing stock and bond portfolio during the decumulation phase. I’m 57, my wife’s 62, and we intend to retire in 2 to 3 years. We have a portfolio consisting of pre-tax, brokerage and Roth accounts. The accounts are allocated for a total return strategy with a target of 70% stocks/30% bonds. We intend to hold 1 to 2 years of cash during retirement with the bond portfolio accounting for around 4 years of our annual expenses. While we’ve been working we have been rebalancing the stock holdings based on percentage of the sector targets as well as the 70/30 stock/bond target.” Wow Tom. He’s getting sophisticated in his strategy, isn’t he Big Al?

Al: He is.

Joe: “My question is, how we- should we start rebalancing the stock/bond percentages in retirement?” So he’s pretty good on the accumulation phase. He’s got a little sector rotations. He’s got the 70/30 split. He’s thinking hey we’ve got a couple of years in cash. The bond portfolios, he’s kind of holding on to about 4 years of our overall living expenses. But now when he starts taking money from the portfolio, does the strategy change? So he goes “our strategy during retirement is to draw down the cash and bond portfolio during market corrections or bear markets. My concern is during a prolonged downturn the bonds could come less than the 4 years of living expenses if we rebalance back to the 70/30 target. What are your thoughts on rebalancing the stock/bond portfolio during downturns while in retirement?. Thanks for answering my question.” Tom, really good question because this is key in regards to creating income in retirement. And he’s right, saving for retirement and then creating retirement income are two totally different things. So your investment strategy is different. Your tax strategy is probably a little bit different. Because now you’re not adding to the portfolio where volatile markets or long downturns in the market actually help your retirement out significantly. Because you’re buying those really good companies that you have been at a lot cheaper price and your dollar cost averaging into the market. Let’s say if you’re saving into your 401(k) plan, and then when the market recovers, your account recovers. But when you start taking money out of a retirement account or any brokerage account for that- or any investment account I should say- in a down market, it’s reverse dollar cost averaging. And then that’s where people get into trouble and then that’s when people run out of money. Because let’s say if you lose 30%- I have $100,000, I lose 30% of that. But the next year I gain 30%. I still don’t have my money back. And I think Alan people don’t understand that math.

Al: And the reason is because if let’s just say $100,000- easy math- you lose 30%. So now you got $70,000. You gain 30%; 30% of $70,000 is $21,000, so now you got $91,000. So you’ve got to earn more like 40% or 45% to get back to even if you lose 30%. That’s part of the problem.

Joe: And if you’re taking money from the portfolio, now you need a lot larger rate of return to get your money back.

Al: You do.

Joe: So if you’re down 30% and you’re taking 5% out to live off of and then all of a sudden it’s like it’s so hard for me to recover in a down market as you’re taking distributions. So Tom’s- I’m sorry go ahead.

Al: I was just going to say it’s a really good question because if he sticks with the 70/30 allocation, 70% stocks/ 30% bonds, and let’s say the market has a major decline it means you’re going to be selling off some of your bonds to buy stocks because that’s what you do. That’s how you rebalance. And now all of a sudden you’re not going to have 5, 6 years in fixed income to cover your expenses. So I guess the way I would answer it is upon retirement that could be an appropriate time to change your allocation. Because there’s a life change. We don’t think it makes sense to change your allocation because of the market or because of a political event or something like that. But when your life situation changes i.e. you’re no longer accumulating, now you’re de-accumulating, you might want to go a little bit more conservative just because of that. So let’s say you’re 60/40 or even 50/50- just to use those examples- now when you’re rebalancing you probably still have 5, 6, or even 7 years, even at a down market in fixed income which is kind of what you want. Because you can let the stocks run their course. Eventually, they’ll recover, but you’ve got plenty of money to live off of in the meantime.

Joe: Because if he only has 30% of his money in cash and fixed income, if there’s a significant downturn in the overall market, you want to rebalance. And what rebalancing means is taking the safe money that hasn’t gone down in value to buy those stocks that have gone down in value. So they’re buying more shares. But as he’s doing that, he’s running out of liquid cash to live off of because he doesn’t want to sell his stocks when they’re down. He wants to buy the stocks when they’re down. So I agree with you 100% Al. He needs to look at the planning a little bit differently to say maybe I want not 4 years of safe money; maybe it’s closer to 6 or 7 years of safer money but then look at the stock allocation of the portfolio. Maybe he might want to take on a little bit more risk there. Because he might be all in large company growth stocks, but does it make sense to have an allocation to small value or smaller companies, emerging markets, things like that, that will give you a higher expected rate of return long term, just because of the volatility and the risk nature of those stocks? So he can have less stocks in the portfolio but still shoot for a solid rate of return in the overall portfolio. So great question Tom. Hopefully that helps answer it. If not, sorry. Call another show

CAGR, ROR, IRR: How to Calculate Return on Investments

Joe: Priya. Friend Priya. “Hey Big Al”. What the hell is this all about, Priya?

Al: Well, she’s talking about CAGR.

Joe: It’s the wrong kind of CAGR. If it was a beer kegger-

Al: Then she’d be asking you. She’s talking about a financial CAGR.

Joe: Got it. “Big Al, Joe and Andi. Thanks for answering my first question in podcast 289. I appreciate it very much. In that podcast, we were wondering if I was the intern who worked in your office. No, no it’s not me. And you asked about my dog’s name, which is Henry.” Priya and Henry. All right. I wonder if you call him Hank. “This week I have a simple but very confusing question. I’m trying to figure out the calculation or how to calculate the investment return and found these formulas commonly referred to on-line. It’s 1, ROR, rate of return.” So that’s ending balance minus starting balance divided by starting balance. You with me here Al?

Al: Gotcha. I agree with you too. Go on.

Joe: CAGR. Compound annual growth rate.

Al: As opposed to beer, it’s not beer.

Joe: I like the other kegger. “IRR, internal rate of return, or any other formula. Rate of return looks simple and easy to user, but doesn’t take into account the number of years. The CAGR formula includes the number of years. IRR sounds very complicated. My assumption is investing starting balance of $1000 on 1/1/2018. A balance of $1300 on 12/31/2019. No dividends and no money has been withdrawn. For example, I get an ROR, rate of return, as 30%, a CAGR of 14%. Could you please clarify how to calculate the performance of this account? Looking forward to hearing your discussion and answer for my question in the next podcast, as always very informative and fun podcast. Thanks.” So Priya, getting into the weeds just a little bit here.

Al: She is. Well ROR, or rate of return, that just gives you from point A to point B, what you made, And you’re right, Priya without regard to a year. I mean what if it takes you 10 years to earn this? It wasn’t that great a return. Or it takes you 50 years for your investment to go up 30%. You didn’t really do that well. So that’s kind of a rudimentary measurement. The CAGR, compound annual growth rate, is definitely better because now you’re looking at years and you’re figuring out what’s the compound annual growth rate each year. In other words, if I would’ve got 14% for 2 years in a row, then I would’ve ended up with an extra $300 on my $1000. So let’s think about that. So the 30% on the rate of return-

Joe: Over 2 years is about-

Al: – over 2 years. And if you divide that by 2 years you would get 15% so you would expect why isn’t it 15%? And the answer is because that first 15% that you earned in year 1, then you have earnings on earnings, that’s compound interest. So it’s a lower percentage.

Joe: So you don’t need to make as much to get to the 30% because you’re making money on money.

Al: Making money on money. Now internal rate of return is, you can explain that a lot of ways, but I’ll keep it simple. Basically, it’s the same thing as the CAGR, except it’s computed usually monthly. Or it could be daily. But usually, on your financial calculators, you do it on a monthly basis. So the internal rate of return is even a little bit lower because now you’re compounding each month instead of compounding once a year.

Joe: Where you would want to use like internal rate of return would be let’s say for those of you that have a pension and you would get a lump sum of X or a monthly pension payment of Y. So you would say okay well what’s really the internal rate of return of the monthly pension payments? Does it equal the lump sum or is it higher? If it’s equal or higher, well then you would take the payment. If it’s equal or lower, then you would probably take the lump sum. So when it comes to some of these annuity products we look at IRR, when we look at life insurance death benefit, we look at the internal rate of return. So let’s say if I had a shortened life expectancy and I had a life insurance policy and it’s like well do I want to keep this or not? Or whatever? And then it’s like if you keep it and you pay x amount of premiums and if you pass away let’s say at age 80, your internal rate of return is X. But if you live until 90 your internal rate of return is a lot lower. So certain things like that is where all of these come in handy, it just depends on when you want to use them.

Al: I think so too. I used to use and still on real estate investments, internal rate of return, is really handy. Because you’re looking at cash flow; you’re looking at appreciation; you’re looking at in some cases potential tax benefits and paid out of mortgage and you’re combining those all together to figure out, what did you start with as an investment? And what did you end up with? Let’s say if you sold it 5, 10 years down the road minus taxes, that’ll tell you your internal rate of return and sometimes those are computed before tax and sometimes they’re computed after tax. It just gives you a sense of what you’re making on an investment.

Joe: Thanks for the question Priya. She is definitely-

Al: Not the intern?

Joe: No. Yes. The intern didn’t know that.

Al: CAGRs?

Joe: Love the intern, but- Priya’s pretty smart there. Like it.

Learn ways to grow your investments in all market environments, how to avoid poor investment decisions, and how to protect yourself from risk. Download 8 Timeless Principles of Investing for free from the podcast show notes, just before the transcript of today’s episode. It’ll help you feel more confident in your portfolio even in times like these when markets are volatile. Click the link in the description of today’s episode in your podcast app to go to the show notes and download 8 Timeless Principles of Investing and to Ask Joe and Al your money questions.

Step Up in Basis and 401(k) Beneficiary: Spouse or Living Trust?

Joe: This show wouldn’t be a show without Smitty. Swear to God, Smitty, you’re killing me. Every week it’s like fifty emails from the guy.

Al: Yeah I know right?.

Joe: “Hi Andi, Joe and Big Al. I really appreciate all your help. I have a couple more questions.” Imagine that. “First is about step-up in basis. I have a brokerage account that is titled to my living trust. When I got married I updated the living trust where my wife is now the sole beneficiary of the brokerage account. So it begins with trust and not a TOD. So does my wife get a full step-up in basis?” So he switched it from a transfer on death to a brokerage and he just now titled Smitty’s trust for the benefit of his beautiful bride. So I guess it depends on how it was established but I would say in most cases, yes. But I’m not an attorney.

Al: But let me just chime in there. Oregon is not a community property state. But it sounds like maybe it’s a separate asset in a separate property asset potentially. So if that’s the case, it could be a full-step up; although I’m not sure if you put it in your living trust and if she’s part of it, maybe it taints it. That’s a that’s really a legal question. That’s over our heads.

Joe: But no, it’s-I guess- if he dies- and she’s the sole beneficiary, of course she would get a step-up in basis. It’s just a look-through, see-through living trust. It’s just the-

Al: Not necessarily.

Joe: If she’s joint owner and it’s not- okay go ahead.

Al: Well I was gonna say if she’s a joint owner and I don’t know if he puts the property in his trust or is she in the trust? I don’t know. But if they’re- if she’s a joint owner then she only gets a half step-up in basis because Oregon is not a community property state. In California, she would get a full step-up in basis because it’s a community property state. But when you go from transfer on death to trust…

Joe: All it does is avoid probate. As long as it’s titled appropriately it’s going to get a full step-up in basis.

Al: Right.

Joe: You don’t believe that?

Al: Let’s see…

Joe: I can tell how you answer me sometimes, you’re like ‘right’. You’re like I don’t know, you’re hesitant.

Al: Well because he’s married. It doesn’t get through probate when you’re married. It gets transferred to the spouse. Al: She’s got to go to the courthouse, ‘please, I really did marry him’..

Joe: So he’d named his wife the beneficiary of the trust. So it depends on, is it like a separate property trust is what you’re thinking, right?

Al: That’s maybe- that’s probably a better-

Joe: You’re getting more complex than needs- this is Smitty we’re talking about.

Al: And he apparently rides a Harley we found out.

Joe: Smitty gets married and he goes ‘all right honey let’s get a living trust. Let’s establish the living trust’ and he’s the beneficiary on her assets. She’s the beneficiary on his assets. Maybe these are separate property assets or was it in a irrevocable trust? I think is just the standard living trust. He’s a trustee. I would imagine she’s the trustee of the living trust as well. And then they’re- she’s the beneficiary if he dies, she would get a step-up in basis and avoid probate if it was separate property.

Al: So I’m not sure that’s right. They do avoid probate. But if it’s his trust and it’s his property and she inherits it, I think maybe it’s a full step-up but I’m not sure what happens when you’re married. See we’re not attorneys so we don’t really know. If it’s jointly owned then she only gets a half step-up in basis because it’s not a community property state. That’s what I was trying to say.

Joe: Got it. So he’s got a 401(k). He’s going to title the living trust as the beneficiary or should he just name the wife? I would just name the wife. It gets too complex if you name a trust because there’s requirements with a living trust. And it’s your wife, it’s your spouse. So name her and then the trust later because there’s no kids. It will make it easier depending- because there is a delivery requirement needs to be, look-through, see-through trust. There’s other things. If you have other beneficiaries besides the wife on the trust, it could tend to get a little bit sticky. So let’s say the trust, the 99% of the IRA is the wife and the 1% is as a charity. You could run into some issues there. So I would just name the wife first beneficiary, then the trust as the contingent. So thanks again Smitty for the for the great questions. Smitty, the regular listener comes to us each and every week with about 15 questions. Al and I usually have a tough time answering.

Al: We fumble over them.

Andi: And he keeps coming back.

Al: We do our best.

Joe: But he gave us a review. He gave us- he wanted 6 stars. Because there was the guy, Longtime in China or something like that? Deducted 1 star from our podcasts because of the banter that we have.

Al: Yeah apparently we’re still too silly or something.

Joe: “But my squeeze and I enjoy the banter.” Squeeze. Smitty. You gotta love Smitty. “Please continue with the Dverails. P.S. All the guys down here at the Bait Shack think you’re all a riot.” I’d love to go to the Bait Shack there in Roseburg, Oregon.

Al: I would too.

Joe: Have a couple of pops with Smitty and the squeeze.

Andi: That sounds like a band.

Al: That should be the name of a band.

Joe: That’s the name of our next podcast.

Andi: Smitty and the Squeeze.

Al: I like that.

Joe: Smitty and the Squeeze.

CARES Act & SECURE Act: When Do I Have to Take My RMD?

Joe: Stanley writes in from Midlothian, Virginia. ” I turn 72 in 2021 and will need to take my RMD. Must I take it in 2021? Or can I postpone it to early 2022? I understand if that is possible that I would need to take a second RMD before December 31st, 2022. Or did that option disappear?” Just vanish.

Al: You never know, with the CARES Act, the SECURE Act, what are they doin’ to us Joe?

Joe: We got the Disappear Act. “Also, if I can postpone the 2021 RMD to either early 2022, may I convert Traditional IRA money to a Roth without the IRS considering it an excess contribution? Thank you for your efforts on behalf of your audience.” All right Stanley. Couple of things that you’re right on, and a couple of things that you’re off just a smidge. I’ll take a stab and Al, if you want a rebuttal, that’s cool. So “must I take it a 2021?” He turns 72 in 2021. If he turns 72 in 2021 he can postpone to 2022. He can- his required beginning date would be April 1st of the following year. So he is correct there. He can postpone his required minimum distribution. And what that is, is that it’s a mandate by law that you have to start taking dollars from the 401(k) plan or IRAs or whatever. Now at age 72, it was 70 and a half and SECURE Act pushed it out to 72. So he’s looking to postpone it. But yes you’re correct. You need to take two distributions by the end of 2022. So you have to make up for 2021 and then you have to take your 2022 required distribution. So can he do a conversion in 2021? The answer is yes. But it’s not an excess contribution. It’s just a conversion. So he might be thinking if he converts the RMD, that would be an excess contribution which would be subject to a 6% penalty per year that that the conversion is in. But as long as he postpones his required- it’s based on the required beginning date and the required beginning date is April 1st the following year.

Al: I completely agree. I think that the fact that you don’t have to take an RMD in 2021 means that you can do a Roth conversion without a problem. 2022, totally different story because now you have to take two RMDs. Joe I believe that he would have to take both RMDs before he did a Roth conversion in 2022. Would you agree with that?

Joe: Yeah. Without question. So he could do the conversion in 2021. But if he does a conversion before the required distributions- the RMDs have to come out first before- then that would be an excess contribution.

Al: Yes. So in 2022 you do your first RMD and your second RMD. Then you can do Roth conversions. 2021, you’re good because you don’t have a requirement yet.

Joe: There is no requirement. Same with 2020 because they get rid of RMD. So if he was 72 or 73 this year you could do a conversion of your required distribution because you don’t have to take one. So Stanley has the next few years to do conversions. But yeah 2022. he’s going to postpone it. He would have to take both RMDs before he did a conversion if he wanted to do a conversion in 2022.

Should I Contribute to Roth IRA Instead of Traditional IRA?

Joe: Let’s get back to the email. Scott writes in. He goes “Hey Joe.” Oh no. He goes “Hey Andi, Al and Joe.”

Andi: He just skips right to himself. You notice that Al?

Al: He does, right?

Joe: “Thanks for always putting on informative and humorous content. Nothing better than learning and laughing all in the same podcast. I previously emailed about potentially converting my employer match Traditional 401(k) to Roth, which you spoke about but did not advise.” That’s right Scott. We don’t give advice here. Just chat about it. “- which you spoke about to stay the course to have some tax diversification in retirement. Now I’m curious if it would make sense to switch over my future contributions to Traditional from Roth currently; although maybe I should wait until after the election for more tax clarity. I currently maxed out my contributions to my Roth 401(k) and my Backdoor Roth IRA, combined value of $160,000. Have a Traditional 401(k) from employer match, has about $45,000 in there. Have a brokerage account $30,000 that kicks out tax-free income, Muni-type investment. I also asked after listening to your show I learned about the Mega Backdoor option which I plan to utilize this year just an additional $5000 for these Mega Backdoor.” That’s the Garage Door Al. We lost Andi again.

Al: We did. So we’re probably not on.

Joe: Hold on, I think we are still going. We’re going to keep going here.

Al: Yeah the show must go on the show. Right?

Joe: Yeah. With or without Andi. So he currently- let’s see- “I currently sit at the 35% federal tax bracket, income of $205,000 and about 6% for New Jersey state tax. I expect to be in that tax return until 2023. So before moving to the next bracket I’m single, to be married in 2022.” Couple years there Scott. “I’m currently 30 years old.” That’s a little young Scott, to be getting married. Maybe you should hold out a couple more. Give me some advice there. I’ll definitely give you advice there. Hold on.

Al: I got married at 31. That was a good age for me.

Joe: I’m in my 40s and still loving every minute of my single life. “Given my current tax bracket, do you think it makes sense for me to switch contributions to Traditional for now? Or should I stay the course and just have my employer match build my Traditional account exposure? Thanks again for all you do. You make the midweek commute quite enjoyable.” All right Scott from Jersey. So I think Al, you were telling him maybe go pre-tax, have some tax diversification. He’s going all Roth. He’s like Mr. Roth. He’s 30 years old, he’s got $160,000, maxin’ that thing out. He’s going to do the Mega Backdoor, Garage Door Roth, he’s got $200,000 of income, he’s 30, he’s sittin’ in the 35% federal tax bracket. It probably does make sense for him to switch to go to pre-tax.

Al: To get the tax deduction. So he’s single and let’s see- his income of $205,000 plus- I don’t have the tables in front of me- but I think that’s the 32% bracket. But anyway it’s pretty close to 35%. Either way it’s a higher bracket. You could use a little bit more diversification. So it’s almost a toss up Joe, I’m not sure how much information we had the first time we answered this question. But at age 30, making that kind of money, chances are he’ll be making a lot more money later perhaps, and maybe you’ll be in higher brackets. On the other hand, if he gets married the top of the 24% bracket goes from about $170,000 to about $325,000, so there’s more room. But maybe his future wife makes a lot of money. We don’t know. There’s a lot of information needed to really assess this properly. But I guess the general rule I would say is when you’re young and potentially lower brackets, although I guess Scott’s acted in a pretty high bracket, you kind of want to favor Roth. And as you start making more and as tax rates go up, because they’re kind of an all time lows right now, then you might want to switch more over to the pre-tax.

Joe: There’s two rules of thumb that I usually look at. You can do the scientific way of saying you’re in the 32% tax bracket. It’s a pretty high bracket, might make sense to get the tax deduction. But are you going to save the tax savings that you get by putting them into pre-tax? The answer is usually no.

Al: Usually, right.

Joe: If you put it in Roth you’re never ever going to be taxed on those dollars again. It’s going to compound tax-free. And then when Scott, because he’s a good saver, all of that money- he takes the uncertainty of future tax rates just off the table. So I don’t know. Some people- if it’s a flat tax it could be lower, all this other stuff. I guess you could have left some stuff on the table. But at the end of the day it’s hindsight. Now you’re retired and you don’t have to worry about it versus saying hey I saved a couple of bucks now I’m screwed. Now I’ve got- I owe all this money in taxes.

Al: And it depends upon the age too. So I would say if Scott was 62 with the same exact fact pattern, he doesn’t have that much in a 401(k), so I’d get the tax deduction because he’d be in a lower bracket. But you know as it stands right now you could argue either way.

Joe: Andi, you’re back.

Andi: I made it. It seems to be a weekly thing. My internet has to drop while we’re in the middle of recording. How far did you get? What did I miss?

Joe: You didn’t miss much, didn’t miss much.

All right Scott. Well good work. Keep up the good work there. Yeah. I don’t know. The Mega Backdoor. I think what that is, is that he might have the ability to put more after tax dollars into the 401(k) plan. If you could do that, absolutely do it. Make sure everyone that’s listening to this, talk to your H.R. to see how much money that you can actually put in your 401(k) plan. Because there are some plans that allow after tax contributions once you fully funded the pre-tax or Roth component of the 401(k) plan. Those after tax dollars can immediately be converted to a Roth IRA. So that’s the Mega Backdoor or the Garage Door. The big bad door. The big backdoor. Whatever you wanna call it.

Whatever kinda door you want to put on your Roth conversion, it’s important to know you’re making the right move before you do it. You can get a deeper dive into your overall financial picture by scheduling a free financial assessment via video call with Joe and Big Al’s team at Pure Financial Advisors. But you need to do it now, before the calendar gets all booked up as the end of the year looms large. Oh, did I mention that free financial assessment is free? Click the link in the description of today’s episode in your podcast app to go to the podcast show notes at YourMoneyYourWealth.com and click the “Get an Assessment” button to schedule yours. Coming up, another question from Priya because we can’t keep up! But first, let’s talk life insurance.

Should I Sign Up for My Employer’s Capital Accumulation (Life Insurance) Program?

Joe: We’ve got a couple videos? Or what the hell are they?

Andi: Voicemails.

Joe: Voicemails. We’re living in the age of Zoom, Andi. So everything now is like a video call.

Andi: Well this one is a video that you’re just gonna have to listen to.

Joe: Got it.

John: Hi guys and Andi. This is John. I have a question. My company recently decided to offer a capital accumulation program. My understanding is that I’m allowed to put money into this plan tax-free, the growth is tax-free, and when I withdraw the money at retirement, it is a loan against an insurance policy, and also tax-free. Is this on the up and up? Or is this something I should pass on? Thank you.

Joe: Okay, so?

Andi: So what’s a capital accumulation program?

Al: Sounds like a good question for you Joe.

Joe: Well it’s a life insurance contract disguised as an investment. Remember those?

Al: They’ve been around a long time, called different things at different times. Same idea.

Andi: But this is offered through an employer?

Joe: It’s probably a small employer. 12- it’s been a while since we used to see all those plans back in the day Al. Anyway, but it’s- here it is. But I don’t understand what he’s saying. So he’s gonna be able to get a tax deduction to put money into this plan. It’s going to grow tax deferred. And when he pulls the money out he’s going to take a loan from the insurance policy and a loan is not a taxable event. So it’s tax- free.

Al: He’s saying that he can put the money into tax-free. I don’t know if that means a tax deduction or not. There’s not a tax cost and there’s not a tax cost because I think he’s already paid tax on the money.

Joe: I’m believing that means that-

Al: You think it’s a deduction through payroll?

Joe: Correct.

Al: _______ ?

Joe: Yes. 12B1I plans or _______- I’m just having a brain fart today. So that’s normal for most days. So it’s nothing new here. But I am familiar with some of these plans. And there are a carve out executive plans and things like that. So I don’t know, should he stay away from it? Probably. I don’t- I would not put my money into this. I would have to look at the contract and how big of- how many contributions are going into this thing. Because it has to be really fully funded for it to work out. Because once you start taking dollars out of this capital appreciation or accumulation program, it’s still life insurance at the end of the day. And who is it underwritten on? Who is the insured? The beneficiary is probably the company but who’s it- who’s it underwritten on? Does John need to go through a – ‘you get a free physical with this capital accumulation program’? Someone’s gonna come out and check your blood pressure. But it’s actually an exam to see if you are getting- for your life insurance. So I mean I went to this sales training one time. This is back in the day because they would call these like these Super Roths, Giant Roths.

Al: Super Roths.

Joe: Remember the Super Roth?

Al: And I when I was a young CPA, before you were in the business, I heard an adviser call it a private pension plan.

Joe: Yes. They still call it a private pension plan.

Al: Do they? Okay.

Joe: They only call it all sorts of BS. But the Super Roth was the best. And then it was like and you’ll also get a free physical.

Al: Side benefit.

Joe: A little side benefit of the Super Roth. So is it a Roth IRA? Yeah but it’s different than a Roth IRA because you don’t have income limits and there’s no contribution limits and you can put as much as you want in here. You get a free exam. That’s life insurance. So that’s exactly what this is. So John I don’t know what that capital accumulation program is. If you get the tax deduction it grows tax ____, if you can pull the money out it would be a loan. You know there’s cost to the loan. There’s cost to the insurance. You would have to run all of those numbers to see if it’s really worth it from the tax benefit because that’s how it’s getting sold. You can tell how he explained it- tax-free going in, tax-free growth. And then when I pull it out it’s tax-free, it would be a loan. So he’s getting- those are the benefits of it. But I would want to get into the details a lot more to see if I would put my money into this. It usually always sounds good on the surface but with all insurance, that’s why it’s insurance, there’s tradeoffs. So what are the tradeoffs that you’re getting? And what other savings vehicles are you taking advantage of? Are you putting money into a Roth IRA? Are you putting money into a 401(k)? Have you maxed out those plans? Do you have money in a brokerage account? How much debt you have? So there’s a lot of other questions that I would want to make sure that you look at before you start throwing a couple of bucks into this plan.

Al: And I think Joe, from my standpoint, I don’t know as near as much about these as you do but I have to say that in general it seems like a lot of the people that get in these plans are sorry they did. Now maybe this is different because there’s just tax deduction and maybe it’s a better one. But I would say as a general rule, the people that I know that have gotten into these kind of wish they hadn’t. So I don’t know.

Joe: Andi, 412I, Google that real quick. 412 I? I believe-

Al: And those are still allowed? Remember they took some of those away?

Joe: Of course. And then you know a lot of times how their positioned, they just talk about the tax code itself. It’s like well have you looked at a private pension under Section 412I of the IRS Revenue Code? It’s like wow that’s sounds pretty- that sounds pretty cool.

Al: That sounds clever right?

Andi: Apparently my internet can handle us actually recording, but it can’t end handle finding out what 412I is.

Joe: I’m just- that just popped in my head. I think that’s what this is referring to. We can kind of look it up and get back to John. So I appreciate the question. If you do have money questions, you get really terrible answers, like we’re giving them today and ___________. You know it’s like ‘I don’t know, step-up in basis, I don’t even know what the hell that is’.

Al: Well all I can say-

Andi: That’s why it’s just suggestions and not actual advice.

Al: I can say we’ll give it our best. Give it a college try.

Joe: College try.

Al: Yeah. You got it.

Joe: We’ll give it a college try.

New Homebuyer Primary Residence Tax Planning

Joe: All right we’ve got Priya from Fallbrook, Fallbrook, California. She writes in “I’m almost 63, just became a homeowner, partner with my fiancé. I put $100,000 and he put $60,000 down as a down payment. I took the money out of my 401(k) plan which I have to pay tax on and my withholding was 44%. Question for you, why can’t I take $10,000 out for first time homebuyer?” Well it sounds like she is a first time homebuyer.

Al: But she can. But she’s 63. The reason for the first time homebuyers is not to eliminate the tax, it’s to eliminate the penalty-

Joe: Penalty.

Al: – early withdrawal. But she’s already over 59 and a half. So that doesn’t even apply. I think Joe, I just want to say sometimes people think they can take the $10,000 out tax-free. That’s false. You can take it out penalty free. You still have to pay the tax.

Joe: “________ withhold work by the end of the year, time to do tax.” Well if you withheld 44% I would imagine that’s probably enough withholding. But here’s the problem. You took the $100,000 out of a retirement account to put as a down payment on a house. So that down payment didn’t cost you $100,000, it cost you about $144,000. So we’ve seen this mistake all the time in regards to pulling dollars of that magnitude out of retirement account to buy a house, to pay down debt, or pay down a mortgage. And then next year they just find themselves into a larger tax issue depending on if they withheld enough. It sounds like she would- I’ve never seen someone withhold that much.

Al: That’s a lot. That would be federal and state. But still, that’s a lot.

Joe: Usually you see 20% federal; maybe 8% state-

Al: Something like that. She does have a question “Is there any tax break during the pandemic?” I suppose if it’s a Coronavirus distribution Joe, she could pull the money out and then pay the tax slowly over 3 years.

Joe: so Priya, do you have- did you get diagnosed with COVID. Did your fiancé get diagnosed? Does the fiancé qualify? I know spouse does; significant other? Don’t have the rulebooks in front of me.

Al: I don’t think it says that, I think it’s the spouse.

Joe: But maybe if Priya was affected in any way financially, maybe furloughed, laid off, lost wages, ________.

Al: Joe, I think that’s where a fiancé could come into play, if you’re sharing rent or mortgage. In this case probably rent because she’s about to buy and if the fiancé gets laid off, they got less, they can’t afford their bills. That that would probably qualify.

Joe: So she’s a homeowner but it cost her an arm and a leg to do it. I would look into this Coronavirus related distribution. Then you could pay the tax over the 3 years where you could spread the tax out over a time period. Or if you have other capital that you could potentially use, you might want to pay that $100,000 back and then come up with $100,000 somewhere else. But likelihood of someone to have liquid capital that much outside of a 401(k) plan, maybe not.

Al: She wants to know should she put her house in a trust- in the trust. And the answer’s yes. If you have a living trust you should put your house in there. That means that it avoids probate upon your passing.

Spousal Social Security Benefits

Joe: Let’s go to Amanda from Riverside. Let’s go. “If I draw a Social Security benefit at age 62, for $1000 a month, my husband’s full benefit at age 67 would be $3200 a month. If my husband waits to draw his Social Security benefit at age 70, for $4000 a month, would I be entitled to switch over to the spousal benefit for $2000 a month? Or would I’d be entitled to $1600 a month? Thank you very much for your help. I truly enjoy your show.” So Amanda is going to take her Social Security at age 62 at $1000. Also benefit is not based on- the survivor benefit is going to be based on Amanda’s husband’s benefit at his death. So if she takes it at $1000 at age 62, her spousal benefit is going to be based on her husband’s benefit at age 67 which is $3200 a month. And if you take $3200 a month divide that by 50 is what Al? $1600?

Al: Yep.

Joe: But if she’s taking her benefit at age 62 she’s not going to receive the full 50% she’s going to receive 33%. So it’s going to match up to $1000 a month anyway. If I had a calculator, I could get really tight on that but-

Al: I think that’s close. I think the two key concepts is the spousal benefit is 1/2 of your spouse’s benefit at full retirement age, not age 70, number one. Number two is if you take it early, it’s going to be a reduced benefit.

Joe: So you can’t game the system that way Amanda. So if you take it early at 62 they’re going to look at your benefit once your husband claims the spousal of his benefit, you could change to the spousal benefit but it would still be a reduced benefit because you claimed your benefit early. So thanks for the question.

_______

Thanks, Smitty and Priya and everyone else for your money questions, you ALL definitely make YMYW what it is, and I’m glad you enjoy the Derails because even though there were plenty in today’s episode, I still got a few more for ya momentarily.

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